Managing Capital Flows in Emerging Markets (EM)

Managing Capital Flows in Emerging Market Economies

201310 1

Recent Trends in Capital Flows to Emerging Market Economies (EM)

Managing Capital Flows in EM: the Expanded Toolkit

Recent Experience with Managing Capital Inflows in EM

Coping with Capital Outflows as U.S. Fed Exits from Unconventional Monetary Policy

Concluding Remarks

2Types of Capital Flows

3Recent Trends in Capital Flow to Emerging Market Economies (EM)4Capital inflows to EM increased sharply in recent years

Gross inflowsNet inflows

Source: IMF, 2013, Multilateral Policy Issues Report, August 1.5Composition of capital inflows to EM shifted toward portfolio flows

Source: IMF, 2011, Recent Experiences in Managing Capital Inflows, February 14.6Push and Pull Factors Affecting Capital Inflows to EM

Source: IMF, 2011, Recent Experiences in Managing Capital Inflows, February 14.7EM/Advanced Countries (AC) interest differentials are wide

Source: Chang, Joyce, Managing Capital Flows to Emerging Market Countries, J.P. Morgan, May 2011.8EM/AC growth differentials are also large

Source: Chang, Joyce, Managing Capital Flows to Emerging Market Countries, J.P. Morgan, May 2011.9EM fiscal and debt indicators compare favorably with AC

Source: Chang, Joyce, Managing Capital Flows to Emerging Market Countries, J.P. Morgan, May 2011.10Volatility of capital flows to EM has increased

Source: Balakrishnan, Ravi, et al, 2012, IMF Working Paper WP/12/130, May.11Capital Inflows to EM: a Blessing or a Curse?Capital inflows bring economic benefitsCapital inflows also bring policy challenges

12Foreign ownership of EM sovereign bonds increased; market liquidity decreased

Source: IMF, 2013, Global Financial Stability Report, October.13Size of capital inflows is large relative to financial depth of some EMSource: IMF, 2012, IMF Working Paper WP/12/130.14

Cumulative Gross Capital Inflows to EM in Selected Asian EM 2010Q1-2011Q2 to Financial Depth 11Financial depth is defined as the sum of equity market capitalization, debt securities outstanding, and bank deposits.Managing Capital Flows:Policy ToolkitMacroeconomic policies

Macroprudential measures

Capital Flow Management Measures15Managing Capital Inflows: Macroeconomic Policy ToolkitExchange rate: appreciate, if exchange rate not overvaluedInternational reserves: intervene and accumulate reserves, if reserves too lowSterilization: sterilize foreign exchange intervention, if inflationary pressures existMonetary/fiscal policy:Lower policy ratesTighten fiscal policy

16Capital Flow Management Measures (CFMs) may be appropriate.

Source: IMF, 2012, The Liberalization and Management of Capital Flows.17Capital Flow Management Measures (CFMs)Macroprudential Measures (MPMs) aim to ensure financial system stability

Capital Flow Management Measures (CFMs) aim to address risks of specific capital flows18Use of MPMs has increased in EM

Source: IMF, 2013, Asia and Pacific Regional Economic Outlook Update, October 11.19Macroprudential Measures (MPMs)Foreign exchange related measures discriminate according to currency, not residency. Examples:limits on banks open foreign exchange positionslimits on banks foreign currency borrowinglimits on banks lending in foreign exchangeOther prudential measures aim to reduce systemic risk, does not discriminate according to currency.Credit related measures, e.g. LTVLiquidity related measuresCapital related measures20CFM MeasuresCapital flow management measures (CFMs) are designed to limit capital flows:Capital control measures that distinguish between residents (R) and nonresidents (NR)

Other CFMs that do not distinguish between R and NR, subset of MPMs

21Classification of MPMs and CFMs used recently in EM

Source: IMF, 2011, Recent Experiences in Managing Capital Inflows, February 14.22Design of CFMS should aim to be:Transparent (priced based)

Targeted to the risk at hand

Nondiscriminatory between residents and non-residents

But most important, they should aim to be as effective as possible.23Recent Experiences in Managing Capital Inflows in Selected EM

Source: IMF, 2011, Recent Experiences in Managing Capital Inflows, February 14.24

Source: IMF, 2013, Asia and Pacific Regional Economic Outlook, April.25

Coping with Capital Outflows as U.S. Fed Exits from Unconventional Monetary PolicyVolatility shock from May 22 taper talk

Mini stress test in EM, affecting:Interest ratesExchange ratesEquity markets

26Sell off of EM Bonds: May 2013 versus Lehman Brothers 2008

Source: IMF, 2013, Global Financial Stability Report, October.27May 22 Sell Off: Impact of EM Equity Prices and Exchange Rates

Source: IMF, 2013, Asia and Pacific Regional Economic Outlook Update, October 11.28Recent Stress in Emerging Markets:Fundamentals Matter

Source: IMF, 2013, Global Financial Stability Report, October.

29Recent Stress in Emerging Markets: Fundamentals Matter (continued)

Source: IMF, 2013, Global Financial Stability Report, October.30What can EM do to cope with further capital outflows and volatility?Tighter financial conditions aheadPossible policy responses:Exchange rate policy: depreciate, intervention to ensure orderly conditionsMonetary policy: central bank credibility important at times of increased risk aversionFiscal policy: let automatic stabilizers work, avoid stimulus, unless major slowdownMPMs and CFMs may be appropriate31Concluding RemarksLarge, volatile capital flows will continue to be policy challenge for EM

Toolkit for managing capital flows expanded:Macroeconomic policy toolsMacroprudential and capital flow management measures

EM should strengthen fundamentals to cope with potential future capital flow surges/reversals as global financial conditions tighten3233